no fee. But maybe you’re planning to get a third party to manage if for you. If so, there will be a monthly fee you’ll have to pay. NO. 9 ‘VACANCY FACTOR’ Then finally, you need to factor in some assumptions based on the fact that despite your best efforts, that property will not be generating any income when it’s vacant in-between tenants. That assumption is often called a “vacancy factor.” So those are the nine numbers. Some of them will be easy to get, but others will require you to make assumptions. Let me help you with those. If you choose to factor in vacancy, I see numbers being used as high as 15 percent of your monthly rent. It should be set aside under the assumption that money will be lost during the time the property is vacant in between tenants. For property management fees, 10 percent of your monthly rent is a safe amount to set aside. You can get homeowners association fees off the MLS listing or from the whole- saler or seller of the property. YOU HAVE THE NUMBERS; NOWWHAT? OK, so what do you do with these nine numbers now that you have them? A great measure that I’ve used and con- tinue to use is called the debt service multi- plier (DSM), which may also be called the debt service coverage ratio (DSCR). These nine numbers are the inputs that will calculate that service coverage ratio. It is really simple to do. First, you calculate your net annual income for that property, very simply using those numbers we just discussed. You take your rent minus taxes minus insur- ance minus repairs (5 percent of the rent) minus vacancy (15 percent of your rent) minus HOA dues and your management
fees. That gives you your annual operating income off of that property. Next, you calculate your annual debt service. That’s also very simple: take that monthly principal payment plus that monthly interest payment and multiply by 12 (months). You get your annual debt service—the amount you spend over a 12-month period in order to service your debt or pay
a 1.0 debt service multiplier is just fine for me,” meaning “as long as my annual net operating income covers my annual debt service, I’m fine because I know I’m getting my monthly equity from the principal paydown that my tenant is doing for me and I’m getting monthly appreciation from that asset.” CONSIDER THE OBJECTIVES OF YOUR PARTNERS But here’s the catch: When you go to get a loan for that property, there’s a pretty good chance that lender is not going to be happy with that 1.0. That’s why I say to target a 1.25 debt service multiplier, because most lenders are going to see that as optimal. So regardless of your own personal objectives or your own personal goals, you’ve got to think about the goals and objectives of your partners—your lend- ing partners, in particular. In conclusion, I wish I could tell you there’s one simple measure for judg- ing the profitability of an investment property, but there’s not. The debt service multiplier is a good and widely used measure. It’s an easy indicator and there’s a good chance your lender is using the same indicator. Whichever one you do choose and how- ever you calculate it, make sure it’s a good solid measure for analyzing your real estate rental investment. •
your loan (comprised of principal and interest). Now, divide that annual net operating income by the annual debt service number. I recommend
using an Excel spreadsheet to set up a template because you’re going to want to use this again and again. You can even find these models for free on the Internet, also.
WHAT’S THE OPTIMAL MULTIPLIER?
Now that you’ve done your calcula- tions, you’re probably going to end up with a number somewhere around 1. It may be lower than 1, which by the way would not be optimal. It may be higher than 1, which is where you want to be. For an idea of what’s good or bad and how to interpret it, most lenders want to see a debt service multiplier (your net annual operating income divided by your annual debt service) of 1.25 or higher. You know if you have a 1.25 you’ve got a good rental property investment by most standards. You’re going to get the cash flow you want. You’re going to have a cushion to cover the unanticipated expenses like repairs or vacancy or the planned expenses like the HOA or property management fees. What’s interesting is that as you come across investors, everybody’s going to have a different answer, a different calculation and a different interpretation. You may have investors who say, “Hey,
Kevin Guz is a Dallas, Texas-based residen- tial real estate investor withmore than 10 years of investing experience. He owns a HomeVestors (or “We Buy Ugly Houses”)
franchise as well as the Clear Key companies, which focus on residential real estate wholesaling, rental property management and self-storage leasing. He also is a licensed real estate agent in the state of Texas. He enjoys sharing his ongoing personal experiences, perspectives and learnings from his start as a part-time or “weekend investor” and full-time corporate profes- sional through his ultimate transition to a full-time real estate investor and business owner. You can listen to his podcasts at http:/ www.blogtalkradio.com/kevinguz.
60 | think realty magazine may :: june 2017
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